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Lala chief could steer iTunes away from downloads

The music service Apple just acquired may have underachieved, but its founder could be the right man if iTunes moves away from downloads and into streaming music.

Correction: An earlier version of this story incorrectly identified the digital music format used at Apple's iTunes. Apple uses the AAC format.

Apple was engaged in a bidding war with Google when it acquired music service Lala, The Wall Street Journal (subscription required) reported on Friday. That helps to explain why Apple agreed to pay $85 million, a sum that I (and others) believed was far too much for a down-on-its-luck start-up.

What has surprised some in the music sector, however, is that Apple is considering a planto create some kind of streaming-music service and is turning to Lala's managers to help oversee the new offering. Sources in the music industry I interviewed Thursday gave varying descriptions of what position Bill Nguyen, Lala's chairman and founder, will occupy at iTunes. But virtually all of them said he and his staff will have plenty of influence over the service should Apple decide to go ahead with the plans.

One of the technology sector's most unlikely rags-to-riches stories may be unfolding before our very eyes.

Consider that Apple--the undaunted music powerhouse that altered the way people buy and listen to music and that will likely generate $2 billion in iTunes sales this year--is now seeking help from a group that cast about the digital-music sector for years, swapped out business models multiple times (without ever finding a profitable one), and basically did little to distinguish themselves.

If you're just looking at Lala's performance in the music sector, this is like the New York Yankees' taking advice from the minor leagues' Lehigh Valley IronPigs.

The big question is what can Lala possibly teach Apple about digital music?

From car sales to tech riches
Apple and Lala representatives aren't talking, but here's the first thing you should know about the deal: Nothing is set in stone yet. The Journal reported that the plans are in the earliest stages and may get altered. My music sources said that Apple has not spoken to any of the four major labels about changing their licensing agreement, which Apple would need to do before launching any new service.

To understand what Google and Apple may see in Lala, one must start with Nguyen, the company's jovial founder.

The son of Vietnamese immigrants, Nguyen (pronounced "win") is charming, wild about surfing and is well known as one of Silicon Valley's smoothest communicators. A so-so student who attended but did not graduate from Houston Baptist University, Nguyen started out selling cars but cashed in big in 1999 when he sold Onebox, an e-mail technology company, for $850 million.

Since then, he has started several other companies in addition to Lala, including Seven, a Wi-Fi software firm.

Eric Schmidt's Google charges were trying to get their hands on Lala, but Apple got the company instead. Greg Sandoval/CNET

He is very close to Eddy Cue, the revered Apple exec who runs iTunes. What may be most important about Nguyen is that he has long had plans to take down the MP3 format. (In Apple's case, the company uses the unprotected AAC format) He has often said that MP3, the digital audio format embraced by so many music fans, is on its way out. He believes downloads have outlived their usefullness and that in the future, consumers will store their music in the cloud instead of on their hard drives.

"Will you ever (in the future) use an electronic device if it's not connected or doesn't have a browser?" Nguyen asked me a year ago. "You've got to face it, there's nothing you don't do in a browser."

Palo Alto, Calif.-based Lala started as an online marketplace where users arranged to swap CDs with each other. Lala then began streaming music to Web-enabled devices. The company would scan a users' computer hard drive and then enable the person to access the same songs--provided Lala had the rights--via the Web.

According to a report in The New York Times, Lala had concluded that it wouldn't reach profitability anytime soon and approached Apple in the hopes of making a deal.

The end of iTunes downloads?
The natural conclusion to make here is that by acquiring Lala, Apple may be laying the groundwork for a move away from the traditional song download. If this is correct, it would be stunning in that Apple has built a retail empire by selling downloads.

If Apple is preparing such a plan, that would suit the music industry just fine. Plenty of people at the top four labels have long been uncomfortable with unprotected music files. The major recording companies favor formats that protect music from being copied and shared. Label executives have also said that selling individual songs isn't a good business as the profit margins are small and it's a not a model that can't grow. Nguyen's ideas appealed to many at the music labels, particularly those at Warner Music Group, which invested $20 million into the company.

In May, Warner announced that it had to write down about $11 million of the Lala investment.

Some of the music execs I've talked to say they see a world where music buyers will leap at the chance to buy a song for life. In a world where music is stored on the servers of big companies, a consumer never has to worry about losing a song library to a broken hard drive or lost music player.

Of course, consumers would likely pay a premium for this life-time ownership and cloud-based service, but many in the industry feel that the public is ready for that kind of offer.

By all appearances, Nguyen could be the architect of this vision at iTunes.

Regardless of Lala's shortcomings, the company created something good enough to lure Google and Apple, two of technology's most successful companies. That alone isn't a bad resume.

And when you look at the $85 million purchase price, Nguyen engineered by far the best exit in the the battered digital music sector in at least a year.

There's something else to keep in mind about Nguyen; he recovers from spills quickly, usually in time to catch the next big wave. Hang 10, Bill.